Economic reporting in the media frequently appears superficial since important economic processes may take decades for their consequences to work through, whereas media typically need fresh daily or weekly news. Economic history provides an antidote to this rush-to-judgement (e.g. Findlay and O’Rourke 2008, Eichengreen and Irwin 2009).
It is in this spirit that my new book, The Age of Equality, argues that we are still experiencing the long-term consequences of the industrial revolution of the 1700s, and that the current state of that process involves a widely accepted compromise between aggregate prosperity and distributional equality.
Unlike political revolutions that can be dated to 1789 or 1917, the industrial revolution does not have a precise date. However, by the early 1800s it had clearly taken hold in parts of northwest Europe. The new industrial production involved factories with division of labour (exemplified by Adam Smith’s pin factory on the UK’s £20 banknotes) which employed increasingly capital-intensive techniques and applied the results of scientific, or at least casual empirical, observation. It was associated with risk-taking entrepreneurs and mobile workers, who responded to price incentives and were rewarded if they made the right decisions. The process was opposed by those enjoying privileges in the pre-industrial economy, e.g. inherited monarchs with absolute power, landowners with serfs or guild members.
Countries adopting the new system enjoyed unprecedented long-term economic growth. They sought and won global markets for their products so that they could expand the division of labour and capital-intensity of their factories, and they established global empires. Success was no secret. The new system spread across Europe, regions settled by Europeans, and a few other places (notably Japan).
Change was resisted by the ancien régime or by imperial rulers. The 1800s were an Age of Liberty because successful economies were those in which people enjoyed sufficient freedom to respond to economic incentives. The pressure to allow such freedom culminated in the 1910s, with the collapse of the great dynastic empires centred in Saint Petersburg, Vienna, Berlin, Constantinople and Peking.
Opposition to unbridled capitalism
Yet, even as living standards increased, opposition to unbridled capitalism strengthened. In all of the high-income countries there is evidence of income inequality peaking around the first decade of the twentieth century.
- In the US, progressives pushed to reduce the power of the rich by antitrust legislation and to protect the poor by social policies.
- In Europe, socialists’ challenge to capitalism was more fundamental.
The great experiment of the twentieth century was a competition between economic systems over which could best balance prosperity and equality.
The principal challenger was the Soviet centrally planned economy. The success of planning in mass-producing a standardised good was highlighted by the Red Army’s successes in 1938-9 against Japan and in the 1941-5 war against Germany. Central planning was also successful in mobilising resources for a specific goal (e.g. sputnik, the first man in space, or winning Olympic medals) and to satisfy basic needs (e.g. housing, education and healthcare).
Central planning was less successful at continuously improving workplace productivity once the initial enthusiasm for Communism or wartime patriotism had ebbed, or in meeting diversified consumer wants once basic needs had been satisfied. Most of all the central planning was hopeless in allocating capital so that diminishing returns were offset by technical change. The clearest statistical indicator of economic failure is the increasing incremental capital-output ratio (i.e how much capital is needed to generate a one unit flow of output) in the Soviet Union from a normal 3-4 in the 1950s to 15 in the early 1980s. By then the economic failure of central planning was obvious to all.
Capitalism’s mixed fortunes
The market-based economies experienced mixed fortunes in the first half of the twentieth century. Memories were dominated by the depression of the 1930s, which fuelled demands for reduced inequality. However, Europe enjoyed economic growth over the years 1919-39, and for North America the 1920s were a period of prosperity and innovation.
Henry Ford extended the productivity of the factory system by combining interchangeable parts with the assembly line, bringing down the price of a car to the extent that by 1929 over 23 million cars were in use in the US, for a population of 123 million. Ford, however, lost its premier position in the 1930s to General Motors, which adopted assembly line production and offered a choice of models and colours.
The interwar period also saw the spread of vacuum cleaners, which required novel marketing to convince housewives of their value; of refrigerators, whose value was augmented by Clarence Birdseye patenting an effective frozen food technology, and of washing machines, whose use was increased by the innovation of laundromats. These durable consumer goods were all items that central planning was poor at producing in a range of attractive models accessible to a mass market.
The 1989 watershed
By 1989 the victory of market-based economic system was clear, but the winner was not pure capitalism. Governments intervened not just in the classic roles of supplying law and order and public goods, but also to provide greater equality of opportunity and outcome. In a market economy people are rewarded according to the value of their marginal product, but this is low for the old, the sick, or the handicapped People may lose their source of income for reasons beyond their control, and require time to search for the best new source of income. The children of rich parents get a better start in life through better nutrition, healthcare and education. In all of these areas, governments intervene. The relative focus on equality of outcome and equality of opportunity vary, but the desirability of intervention is no longer a matter of serious disagreement.
On a global scale, the gross inequalities of the early 1900s have been eroded. In the mid-1900s empires were dissolved and modernising governments came to power. Influenced by Soviet success, most regimes adopted economic systems with a heavy state hand, which succeeded initially in mobilising resources, but whose limitations were clear by the 1970s. In the final quarter of the twentieth century, country after country adopted more market-based systems and integrated into the global economy. These emerging economies included some of the world’s most populous countries, i.e. China, Mexico, India, Brazil, Indonesia and many more.
Emerging economies: Mixed models
The emerging economies are clearly market-based, but none embraces pure capitalism. Even Hong Kong, the most capitalist economy even while a colony, provided efficient social services and universal public education and healthcare. By the early 2000s, the market economy, and associated pressures for liberty and equality, held undisputed status as the desirable economic system.
This is not the end of history. Debates, rightly, rage in democratic market economies about the appropriate balance between market-driven prosperity and state-mediated equality. In the US the current focus is on healthcare, and in Europe and Australasia on funding for tertiary education. In all countries, aging populations and archaic pension rights pose serious challenges.
At a global level, tensions between established and emerging powers, unlike in 1914-45, cannot be settled by total war. The presence of weapons of mass destruction, cross-border environmental issues and global warming, the responsibility to protect citizens from barbaric governments and the dangers of rogue states all point to the need for international cooperation. The WTO with its almost universally agreed, and abided by, rules for trade despite the lack of serious enforcement mechanisms is an example of imperfect, but functioning, mutually beneficial cooperation. Governance of other multilateral institutions established in the 1940s (the UN, IMF and World Bank) clearly requires reform, while some global and regional problems may require novel institutions. Initiatives like the Svalbard Global Seed Bank, which is supported by regimes as varied as Zimbabwe, North Korea and Syria, provide insurance against inadequate crop biodiversity. The twenty-first century will be the Age of Fraternity because cooperation will be required in the global economy, even though the process may be slow and uneven.
What are the implications for the nearer future? Politicians who rail against socialism or the market always adopt a more moderate stance after they come into office – not because they are cowed by outside forces, but because this is what their electorates want. At any point in time, some voters will be animated by encroachments of the state or by market-generated excesses, but these cannot plausibly be seen as appeals for unfettered capitalism or central planning. The reality is of choices within a narrow band whose limits have been determined by a quarter millennium of economic history.
Findlay, Ronald and Kevin H O’Rourke (2008), “Lessons from the history of trade and war”, VoxEU.org, 10 March.
Eichengreen, Barry and Douglas Irwin (2009), “The protectionist temptation: Lessons from the Great Depression for today”, VoxEU.org, 17 March.